Chapter 7: Developing a Pricing Strategy 7-1
Chapter 7: Developing a Pricing Strategy
I.
The Importance of Pricing
A.
There may well be no other component of the marketing mix that
managers become more infatuated with than price. There are only two
ways to grow revenue.
1.
The revenue equation is pretty simple: price times quantity.
a.
You can raise your price
b.
You can increase the quantity you sell
B.
Pricing is the easiest of all marketing variables to influence, and the
changes can take place immediately.
C.
The fact that prices are easy to change, and in fact change quite frequently
(particularly in this age of e-commerce), they should not be taken to mean
that most firms do a good job of setting prices.
1.
Many manufacturers, wholesalers and retailers readily admit that
they worry more about price than actually manage price.
2.
Consumers also become very frustrated by pricing.
II.
The Role of Pricing in Marketing Strategy
A.
Pricing can be a major source of confrontation between sellers and buyers.
1.
Sellers want to sell the item for as much as possible.
2.
Buyers would love to get the items they want for free.
B.
Managers developing a pricing strategy should base their decisions on a
careful consideration of costs, demand, customer impacts, and
competitors’ prices.
C.
A firm that fails to cover both its direct costs (finished goods/components,
materials, supplies, sales commission, and transportation) and its indirect
costs (primarily overhead issues such as administrative expenses, utilities,
rent, equipment, etc.) will not make a profit.
D.
When the availability of a product is limited, innovative firms today are
also addressing a new cost: opportunity cost.
E.
The fact that costs are covered with a set amount from a pricing model
does not mean that people are willing to pay that price. Inefficient firms
are quickly run from the marketplace as consumers go with more efficient
competitors. The manager must know what consumers are willing to pay
for an item or service.
F.
A selling organization should be very much aware of what its competitors
are charging for the same or comparable items.
1.
While all firms should be aware of competitive prices, they should
resist the temptation to blindly meet or beat all prices.
2.
Companies should think in terms of being in a price range when it
comes to its competitive set.
G.
As marketing managers work to set prices that give the firm and the
product the greatest chance for financial success, one eye must be kept on
how the price will meld with other mix elements to create an overall
positive evaluation of the purchase decision.
Chapter 7: Developing a Pricing Strategy 7-2
H.
I.
III.
Value assessment is an effective way to integrate marketing activities.
1.
It includes the concept of quality, although it is a much broader
term.
2.
It takes into account all four marketing mix elements.
3.
It can be used to consider explicitly customer perceptions of the
marketing mix in the strategy development process.
Shifts in the balance of power between a “buyer’s market” or a “seller’s
market” refers to who holds the power in the exchange relationship.
1.
During a seller's market prices go up and terms and services
become less favorable.
2.
At the present time the perception is that it is a buyer’s market.
With all of the e-commerce start-ups buyers have more choices
than ever before.
Understanding Price Elasticity
A.
Price elasticity is the relative impact on the quantity demanded for a
product for a given increase or decrease in the price charged for that item.
The following formula is used to calculate elasticity:
Percent Change in Quantity Demanded
Price Elasticity of Demand = _____________________________________
Percent Change in Price
1.
B.
C.
For products where the above calculation produces a negative
fraction (negative due to the general inverse relationship between
price and quantity demanded, a downward sloping demand curve),
the item is said to have an inelastic demand.
2.
When elasticity is a number less than or equal to a negative 1.0 the
item is said to have an elastic demand.
3.
The price and other marketing factors associated with products that
can be used instead of, or with an item, must be considered in
assessing elasticity.
4.
When a new competitor enters the market place with a product that
customers see as comparable to the item in question, the elasticity
of that item will become more elastic.
Substitute and Complementary Products
1.
The price and other marketing factors associated with products that
can be used instead of, or with an item, must be considered in
assessing elasticity.
2.
When a new competitor enters the market place with a product that
customers see as comparable to the item in question, the elasticity
of that item will become more elastic.
3.
Complementary products demonstrate the exact opposite
relationship when it comes to impacts on elasticity.
Product Differentiation
1.
The basic goal of differentiation is to make the demand curve for a
product more inelastic.
Chapter 7: Developing a Pricing Strategy 7-3
2.
D.
E.
F.
IV.
Differentiation reduces the number of perceived substitutes for a
product, ideally to zero.
Total Expenditure
1.
As a general rule, the smaller the total expenditure to purchase and
use an item the more inelastic the demand for the item will be.
2.
Some exceptions to this guideline are products that have their
prices heavily promoted tend to be more elastic.
Situational Influences
1.
The nature of the circumstances that surround a purchase situation
can vastly alter the elasticity of demand for an item.
2.
Such situations can alter the number of substitutes available, and
make an immediate purchase mandatory.
The Revenue/Profit Relationship
1.
Firms do not stay in business by selling products; they stay in
business and prosper by making a profit on the products they sell.
2.
Cutting prices is seen by many managers as a quick way to move
excess inventory and generate short term revenue, but it may end
up having severe, negative consequences on the firm’s bottom-line.
3.
It is better for a manager to find ways to build value and justify the
present price being charged, or even a greater price, than it is to cut
prices in search of volume.
Major Pricing Strategies
A.
While prices for individual products must be made on a case-by-case
basis, most organizations have developed a general and consistent
approach known as a pricing strategy to be used in coming up with those
prices.
1.
The selection of a pricing strategy should not take place in
isolation from other strategic decisions.
2.
The final selection may result in a modification of the product,
distribution, or promotion strategy.
3.
It is not so much the actual price being charged that matters, as the
way that price is perceived by members of the target market, that
impact their buying decisions.
B.
Approaches to have the actual price seen in as positive a light as possible
under the circumstance is known as psychological pricing. Some of the
more common approaches are:
1.
Prestige Pricing - Firms set their prices at the top end of all the
available products in a category. This is done to promote an image
of exclusivity and superior quality.
2.
Odd/Even Pricing - Most prices are not nice round numbers. Oddeven price works because it makes the seller look like he did
everything possible to get the price as fine (and thus as low) as he
or she possibly could.
3.
Reference Pricing – Reference pricing has a strategy of going to
market with products just slightly below most of the competitors.
Chapter 7: Developing a Pricing Strategy 7-4
a.
4.
While consumers may not know what they intend to spend
when they go to the store, they use the mix of products and
prices as an information source to create the range of
available options.
b.
Reference pricing is also used when sale prices are
compared to regular prices.
Price Bundling - Price bundling has also been called solutionbased pricing or all-inclusive pricing.
a.
This approach brings together two or more complementary
products for a single price.
b.
At its best the bundled price is less than if the items were
sold separately.
V.
Fixed Versus Negotiated Prices
A.
While generally new to the consumer marketplace, negotiated pricing has
long been widespread in business-to-business marketing.
B.
In a negotiated situation there are three levels of price that both the buyer
and the seller need to understand and plan.
1.
The opening position is the figure that each side will put on the
table as a starting point.
2.
The aspiration is the number that each side will use to distinguish
between a successful negotiation and an unsuccessful negotiation.
3.
A concession is a reduction in the asking or buying price as one
moves away from an opening position to subsequent positions.
4.
One’s limit is the least favorable amount either side is willing to
agree to.
C.
Negotiating prices can be a long and frustrating process, but it is the most
logical and systematic way two parties who don’t initially agree with each
other can work to reach an agreement.
VI.
Legal and Ethical Issues in Pricing
A.
Pricing is one of the most heavily watched and regulated of all marketing
activities.
B.
Given that a difference in price can create such a significant competitive
advantage, any effort to artificially give one company an edge over
another is subject to judicial action.
C.
Managers in a company need to talk about pricing strategies and pricing
decisions on a regular basis, but they should never discuss pricing with a
competitor or in the presence of a competitor.
1.
Price fixing (discussions about price with competitors) is illegal
under the Sherman Antitrust Act.
2.
The Justice Department has determined that while following a
competitor’s lead in an upward or downward trend is acceptable,
there can be no signaling of prices for particular products or
services in process.
Chapter 7: Developing a Pricing Strategy 7-5
Questions for Discussion
1. One of the key decisions a manager has to make is to change prices that have been
set inappropriately. What considerations should be taken into account in deciding
if it is the price that is wrong, or if the problem lies in some other element of the
marketing mix?
2. Discuss the variety of situational factors that could come into play and impact
elasticity in the purchase of each of the following products: (1) sporting event and
concert tickets, (2) staples like milk, eggs and bread, (3) an electric generator, (4)
an airline ticket to a beach resort.
3. As you negotiate with someone to give you a ride home from school, what factors
would come into play in terms of how you would set your opening position,
aspiration and limit in terms of what you would pay to get a ride.